Vanishing tax break could curtail short sales of homes

A popular tax break that has saved struggling Southwest Florida homeowners millions of dollars is slated to expire at the end of this year.

The tax deduction on forgiven mortgage debt has been available for the past seven years, one of a number of measures intended to ease financial pressure brought about by the Great Recession.

Experts say its Jan. 1 demise will not only deal a financial blow to those homeowners, but could blunt short sales as an escape route from foreclosure.

“If people can't get the debt relief, they will just throw up their hands and walk away, and foreclosures could rise dramatically,” said Shannon Moore, broker and owner of Green Lion Realty.

Industry experts are hopeful that Congress will extend the Mortgage Forgiveness Debt Relief Act when it reconvenes in January, adding at least one more year as it did during the “fiscal cliff” crisis in late 2012.

“There's a pretty good chance that it will happen,” said Jamie Gregory, deputy chief lobbyist with the National Association of Realtors.

But opponents contend the tax exemption is too expensive — it will cost as much as $2.7 billion over the next two years — and that it benefits homeowners who bought houses during the boom that they could not afford.

Under the 2007 law, homeowners do not have to pay federal income taxes on mortgage debt forgiven by lenders on short sales, loan modifications or foreclosures.

The debt relief was previously taxed as income. If the law is not extended, borrowers will return to paying taxes on the amount written off after a short sale or on the reduced principal of a loan. In many cases, taxes on the forgiven debt can total tens of thousands of dollars for a single home.

Critics say that is tantamount to paying taxes on “phantom income,” said Trey Price, public policy representative with Florida Realtors.

“This is money that is never seen by the consumer and you're paying taxes on it as income,” Price said. “That's not helpful with our economy moving forward, and not helpful to those folks coming out of a short sale.”

The tax break, which applies to principal residences, has been a major motivator for underwater homeowners to choose short sales, a transaction in which lenders agree to allow a home to sell for less than the value of the mortgage.

Short sales have played a key role in the recovery of the region's real estate market. They accounted for 10 percent of October sales in Sarasota and Charlotte counties and 15 percent in Manatee, according to the latest data.

A homeowner with $100,000 in canceled debt from a short sale could face a tax bill of $28,000 or more, depending on their tax bracket.

“A lot of folks don't have the ability, especially after having gone through a short sale, to cough that up to Uncle Sam,” Price said.

Sarasota real estate attorney Evan Berlin agrees that losing the tax break could cause some homeowners considering a short sale to wait, but he does not see a major impact.

“Some short sale sellers will view the tax as a penalty to do a short sale,” he said.

“I still feel that the completion of a short sale, despite the potential tax changes, is still the best way to go. If adequately counseled, most short sale sellers would agree. The consequences of not doing a short sale are more severe than the potential tax implications,” Berlin said.

But Drew Peterson, a foreclosure specialist with the Re/Max Alliance Group in Sarasota, said the end of the deduction will “definitely” lead to fewer short sales.

“That's unfortunate for the market,” Peterson said. “Some owners will decide to stay and work something out, while others will elect the foreclosure route since deficiency judgments are rare.

“Although the effect will be far less pronounced than it would have been last year due to the price increases, we really can't afford any more factors tightening supply,” Peterson said.

Already, the inventory of homes for sale in Southwest Florida is already down to decade-low levels, particularly of homes priced under $250,000.

Short sales became a popular exit strategy for underwater homeowners here and statewide when the foreclosure crisis reached a fevered pitch a few years ago.

Some lenders have even streamlined the process and made it easier and quicker to close such sales, forgiving the unpaid balance of a loan in the process.

But short sales have dropped sharply, down 42 percent in Sarasota County and nearly 31 percent throughout Florida in the third quarter, according to Realtor statistics.

That may be partly the result of banks taking a more aggressive posture to foreclosures through the courts, spurred on by a new state law that gives them greater power to file foreclosures more seamlessly.

Some homeowners — thanks to an improving economy and better job security — also have been able to hold on to their residences.

Unlike last year, the pending expiration of the tax break has not led to a spike in short sale closings at year end.

“There has really been no noticeable change in short sale activity over the last quarter of the year,” Berlin said. “In fact, short sale activity is way down from the first half of the year, and remains somewhat down. We have seen no real rush to complete short sales by year end.”

Florida Attorney General Pam Bondi joined with 42 other attorneys general urging Congress to continue the tax exemption. Its loss could impact distressed homeowners who are working with giant lenders under the landmark $25 billion National Mortgage Settlement, she noted.

“Those who have benefited from certain relief, such as principal reduction and forgiveness under the National Mortgage Settlement, may face significant setbacks, including default and even foreclosure, if the current tax exemption on this relief is not extended,” Bondi said.

The NAR has been pushing for the short sale tax break as far back as 2000, well before the real estate market crash during the Great Recession, Gregory said.

“We would love to make it permanent,” he said. “We think it's pure taxpayer fairness.”

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